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How much cash is a 10% production efficiency gain?

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Do you know what the financial profits were from your production shifts yesterday?

Do you know what a 10% improvement in production efficiency will translate into for your bank account?

Can you quantify the impact of other production metrics such as rejects rates, downtime percentage and on-time delivery performance will have on your financial results?

 

 

 

 

Most of us need concrete examples in understanding complex concepts. Unless we do the detailed calculations, we cannot get our heads around the relationship between performance improvement and how it translates into positive financial results.

It is not unusual to find most business owners only get partial financial statements and often not until 10-15 days after the end of the month. In some cases, well over a month, while having to rely on questionable inventory numbers every month. Is this you?

An example of one of the more complex issues in managing a plastic processing plant is related to the constant shifts in resin prices in relation to the dynamic changes in recipes and efficiency rates during production and how all of this impacts the accuracy of the financial results.

To simplify the calculations for production metrics, you should consider these guidelines that if properly utilized will result in a significant positive cash flow impact for your business.

Tracking production output material contribution is an essential profit volumetric indicator

This simple method will allow you to quickly calculate your profitability by production shift. You simply need to know your material cost usage and the selling price of the part you are producing. By knowing the sales value of the goods you produced minus the material cost used to produce them, this will give you the contribution for the shift or day depending on what time line you want to track. Then, you need to set a target based on your expected financial year forecast for sales, material costs and net profits divided by the number of days or shifts.  Also, please take note that if you have multiple production steps (often called sub-assemblies or work centers) you will need to prorate the material profit contribution for each work centers.

Daily Target = (Sales for the year –  Material costs for the year) / Production days in the year

AND

Daily Results = (Sales Price x Produced QA approved Products) – (Material used x Purchase Price) or (Material unit cost x Produced QA approved Products)

Meeting your daily target will mean that you are in line with your annual forecasted profits. While this is a volume test offering a few details to manage or control, it will ensure that you will know exactly how much you are making or losing every day. This will also confirm the real financial outcome of any performance improvement you make.

Financial aspects can be expressed in terms of managing many parameters such as customer prices, understanding the true costs of machines and labor costs with production process improvements, reducing QA rejects and the use of regrind on material costs and the resulting profit or loss, product by product, customer by customer and then as a whole for the entire company on any shift, day, week, month and year.

Tracking detailed production metrics is also recommended

While you may think it may be more difficult to track detailed production metrics, it is necessary to better understand why you are not meeting the results of the original cost estimate and what opportunities may arise from your current production method with some simple production metrics.

One simple method, for instance, is tracking machine time. This is much simpler than tracking employee time by production work order because one person in many cases can take care of more than one machine at the same time. Labor can be expressed as a relation to machine time. Here is the list of data items you need from your shop floor for each order:

  • Machine time
  • Produced goods
  • Rejected goods
  • Downtime hours (only during production)
  • Material used

This article is not only about calculating production metrics, which is calculated by using the original estimate (i.e. details with the machine production speed, part weight, setup time and cost of the raw material used). The data that is collected above will also provide you with the following basic indicators:

  • Production speed efficiency
  • Capacity Usage of available machines
  • Downtime hours and percentage
  • Raw Material Efficiency

Compiling this data by product or overall results per day will give you the basic metrics required to help you evaluate and determine what opportunities can be realized. Simple calculations can be made to quickly estimate the financial impact on your business.

  • A gain in production efficiency of 10% (or reduction in downtime) will mean that you will be able to produce 10% more goods with the same machines and manpower. If you have the sales capacity, you will increase your profit by the entire sales, less the raw material cost (and electricity) but not the manpower and direct overhead costs. If your labor and overhead is 20% of your sales price and the material is 50%, you will increase your profit by 5% (i.e. 10% x 50%). If you have a sales volume of 10M$, this 10% gain in efficiency will translate to $500,000 in cash savings.
  • A 2% reject rate reduction will result in a 2% production efficiency gain, which means 1% more direct profit. This will also reduce your raw material costs to the bottom line (50% of it). The number can be quite significant in terms of profit. In this case you would recover $150,000 (1.5%) for a 10M$ sales volume for that 2% improvement.
  • Raw material efficiency gain of 5% is a common best practice in the Blown-Film industry when the product tolerance allows it without endangering the product quality. Managing the quality of regrind material, when allowed, can also provide significant gains. Anything you save here goes directly, dollar for dollar, to the bottom line. A 5% gain will mean 5% more profit.

Conclusion

Keeping your production metrics simple means that can you maintain metrics that are results oriented rather than control oriented. It is human nature for owners to put controls into place when a bad surprise happens. Too often, these controls pile up on top of each other and the real important result metrics end up lost in a crowded forest of controls and business owners end up wasting huge amounts of money and resources to maintain these complicated controls. Mechanizing these simple measurements is also key in keeping the recording and reporting costs to a minimum.

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